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8/10/2019 DEveloping Capital Markets in India BCG-CII Report
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DEEPENING OF CAPITALMARKETSEnabling Faster Economic Growth
December
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T B C G C I I | 3
CONTENTS
5 FOREWORD
6 EXECUTIVE SUMMARY
9 CAPITAL MARKETS CRITICAL FOR OVERALL ECONOMIC
GROWTH: THE MACROECONOMIC POLICY CONUNDRUM
12 URGENT NEED FOR REFORMS IN INDIAN CAPITAL MARKETS
15 CAPITAL MARKETS CRITICAL FOR OVERALL ECONOMIC
GROWTH
19 FINDING THE POT OF GOLD AT THE END OF THE RAINbOW
WHERE IS THE ELUSIVE RETAIL INVESTOR IN EQUITIES
21 DEEPENING THE INDIAN CORPORATE BOND MARKET
23 KEY MONETARY REFORMS FOR THE DEVELOPMENT OF DEBT
MARKETS IN INDIA
28 DEbT CAPITAL MARKET REFORMS REQUIRED IN
CORPORATE DEBT MARKET IN INDIA
31 RETAIL INVESTMENT IN CORPORATE bONDS SUSTAINED,
FOCUSED EFFORTS NEEDED
34 BREATHING LIFE INTO THE DEBT MARKETS
37 NATIONAL GOLD PLUS SCHEME TURNING INDIANS GOLD
ObSESSION TO INDIAS ADVANTAGE
40 ROLE OF PE IN THE INDIAN MARKET THE INDIA PE MODEL
43 NURTURING ENTREPRENEURSHIP ECOSYSTEM IN INDIA
TAKING A LEAF OUT OF JOBS ACT
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W present this joint publication from the
Confederation of Indian Industry and the Boston Consulting
Group on Deepening of Capital Markets: Enabling Faster Economic
Growth. This Pulication explores the links etween capital markets
and economic growth underscoring the pivotal role they play in
economic development and suggests measures to develop vibrant
capital markets in the country.
Across the gloe, the financial markets have een a longstanding de-
terminant in the overall economic growth of any country. Stale and
mature capital markets, oth primary and secondary, create efficient
capital raising opportunities for companies and also assist in channel-
izing domestic savings towards capital formationfueling a nations
economic growth. Though Indian capital markets have evolved dra-
matically over the past two decades, they have not yet accomplished
the expanse witnessed in countries like US, UK, Korea, Malaysia or
even Thailand. Uncertain outlook for the gloal economy and height-
ened risk of a much longer period of sluggish growth in developed
countries have further amplified the need to raise capital from domes-
tic sources to finance our countrys GDP growth.
CII and bCG, with the help of memers of CII National Committee on
Capital Markets, have drawn up recommendations aimed at deepen-
ing capital markets by increasing participation from domestic institu-
tions, FIIs and retail investors; creating markets which would help re -
alize Indias inclusive growth aspirations and strengthen investors
confidence in the face of the gloal financial crisis.
We are thankful to the authors for their contributions to the Publica-
tion, each of them an expert in their own right. We would also like to
place on record our appreciation for Mr. Uday Kotak, Chairman of CII
National Committee on Capital Markets for his guidance and leader-ship to the development of the agenda of the Committee as well as
this Pulication.
FOREWORD
Chandrajit Banerjee
Director General
Confederation of Indian Industry
Alpesh Shah
Senior Partner and Director
The Boston Consulting Group
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C for economic growth. In fact, it
has been observed that a developed capital market is a valuable
national asset. Developed capital markets provide for some key
macro economic enefits, including: a) higher economic growth, )
higher productivity and capital growth, c) higher employment, and
d) a etter developed financial sector. In addition, developed capital
markets also provide some micro economic enefits, including: a)
wealth creation for private investors, ) more flexile financing for
companies, c) improvement of governance structures, d) higher cross
order M&A power, and e) driving entrepreneurial ehavior.
The benefits of a developed capital market are immense and these
have een well researched. An oft quoted study y the World bank
(Stock Markets: A Spur to Economic Growth, Ross Levine) has
clearly demonstrated that GDP grows faster in economies with more
liquid capital markets. The reasoning is simpleliquid markets
make investments less risky and more attractive, allowing savers to
acquire and sell assets quickly and cheaply, and y making invest -
ments less risky and more profitale, it leads to more investments
and hence higher growth of the economy.
However, the development of capital markets poses its own chal-lenges. If not managed properly, rapid growth in capital markets can
make the market vulnerale to fraud, volatility, excessive specula-
tion and misuse y select parties. Capital markets ride on the sav-
ings of small and often uninformed retail investors, directly or indi-
rectly. For policy makers, the challenge hence is to strike a alance
between the pace of growth and conservativism to ensure transpar-
ency and roustness in growth.
The Indian capital markets have evolved dramatically over the past
two decades. However, India still has a long way to go. The total
market cap of all the Indian companies is nearly 65 percent of the
GDP today as compared to the US at nearly 90 percent, Thailand
EXECUTIVE SUMMARY
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and Korea at about 100 percent and Malaysia and the UK at about
150 percent. Even starker, the total Det Capital Market (DCM) in In -
dia is only 34 percent of GDP as compared to China at 49 percent,
brazil at 68 percent and the US at 177 percent. And corporate det
market is even smalleraccounting for only 20 percent of all debt in
the case of India. Corporate det in India is nearly 8 percent of GDP
as compared to 16 percent in China, 19 percent brazil and 130 per-
cent in the US.
India has a very high household savings rate. In fact, along with Chi-
na, India has the highest savings rate in the World. If one was to seg -
ment the savings, nearly 50 percent of all savings is in physical as -
sets like real estate and gold, with the remaining 50 percent in
financial assets, of which equity (oth direct and through mutual
funds) is a small percentage, just less than 4 percent of total house -
hold savings.
The aove facts raise a few questions for the Indian market:
1. How can one grow the Equity Capital Markets?To grow the Equity Capital Markets, one needs to look at oth the
key stakeholders, the companies as well as the investors. From the
companies point of view, it would help if the process for IPO / FPO
was made smoother and less time consuming, as well as if the some
of the other regulations impacting the offer were simplified, for ex-
ample preferential allotment, QIP treatment at a level playing field
with retail, etc. At the same time, it would e critical to address the
investor side challenges in terms of increasing awareness, creation of
appropriate products, enaling an efficient distriution and havingfavourale regulations.
2. What can be done to breathe life into corporatedebt markets?It is clear that India needs to really accelerate the development of
the corporate det markets. However, for this to happen, the market
needs traction on multiple dimensions, including: creation of an ac -
tive aritrage free yield curve, enaling liquidity in corporate det
paper to ensure aility of anks to manage asset liaility mismatch,
increasing retail investor awareness, enhanced transparency, im-
proved products and having appropriate regulationsexample re-laxing investment norms for insurance, pensions and PPF; making
the stamp duty regime more investor friendly, having customer
friendly TDS norms, and maye even onds with tax incentives.
Similarly, to attract foreign investments to Indian corporate det pa-
per, it would mean addressing the key issues of staility of India rat -
ing, exchange rate volatility and having appropriate norms for with -
holding tax for foreign investors.
Looking at where India is today in the corporate det market, SEbI,
RBI as well as MoF need to work together in tandem to make a real
difference.
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3. How can the under utilized capital locked up ingold be utilized?Indians osession with gold has made India the largest holder of
gold in the world, with an official estimate of Indias gold holding at
aout 18,000 tonnes. At current retail market prices, this calculates
to more than a trillion dollars of capital. Clearly, a gross under utili-
zation of a lot of capital. And like most official estimates in India,
this is likely to e an under estimate. The question, in this context, is
whether there is some innovative way in which the government can
leverage this large savings pool.
4. Are there alternate source of capital that can betapped? How?Private Equity (PE) has over the last few years grown sustantially
in India. The value of PE investments in the country grew more than
20 times in less than a decade, to over US$ 10 illion in 2011 from
around US$ 500 million in 2002. The key question isHow can In-dia increase the share of wallet of PE in its capital requirement for
growth?
In addition, the question is whether there are other alternative fund -
ing sources for risk capital. For example, is there something to learn
from the JObS (Jumpstarting Our business Startups) Act in the US
The JOBS Act is a good attempt to channel the HNI money to the
newly defined Emerging Growth Company (EGCanother name for
SME entrepreneur / start ups with right ideas for growth sans access
to capital).
The articles on the succeeding pages eachhighlight one of the above questions andshare the authors points of view on howthese could be addressed in India and whatcould be done to make the capital marketsin India more dynamic.
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C segments of
nancial system that help enterprises raise
longterm capital y way of equity or det. In
turn, they also help savers to invest their
money optimally in productive enterprises.
Capital markets comprise nancial institutions,
anks, stock exchanges, mutual funds, insur-
ance companies, nancial intermediaries or
rokers etc.
A growing economy like India, where more
than 15 million youth are added to workforce
every year, needs huge investment on a contin-
uous asis for new capacity as well as for ex-
pansion, renovation and modernization of ex-
isting productive capacity and creation of
supporting infrastructure. This investment,
technically referred to as gross capital forma-
tion, is crucial to sustain growth. Economists
work out capital output ratio by computing
units of capital required to produce a unit of
additional incremental output. In the Indiancontext, the capital output ratio has historically
een around 4, i.e. 4 units of capital are re-
quired to produce one unit of incremental out-
put. Therefore, to sustain growth of 8 percent
per annum, we need new investments or gross
capital formation of 32 percent per annum. In
other words to sustain growth, we need capital
to invest. And to raise capital, we need an effi-
cient capital market. Therefore, capital markets
are critical for the countrys overall economic
growth. There is road consensus that macro -
economic policy framework should be condu-
cive for the development and efficient working
of the capital markets.
However, the development of capital markets
poses its own challenges. If not overseen prop -
erly, capital markets can e vulnerale to
frauds, volatility, and excessive speculation.
Capital markets mobilize savings of naive inves-
tors, directly and indirectly. For policy makers,
the conundrum is therefore to strike a balanceetween pace and order, sophistication and
transparency, and regulations and simplicity.
Over the past two decades, Indian regulators
have taken the path towards tighter regulations.
As a result, in relative terms, our capital markets
have een less vulnerale to crises or frauds.
Quite justifialy, our regulators and government
officials are proud aout this. We have a roust
regulatory structure in place for the capital mar-
kets. However, the flip side is that they are not
geared to meet the capital requirement to real-ize the growth potential of the economy. India
has tremendous potential to sustain higher eco-
nomic growth compared with China because of
favorable demographics and the enterprising
nature of its people. India can sustain doule
digit economic growth for at least a couple of
decades more, which can lift millions of people
out of poverty as has een the case with China,
Singapore, and many other countries.
Let us separately look at equities and det, the
two major parts of the capital markets.
CAPITAL MARKETS CRITICALFOR OVERALL ECONOMIC
GROWTH: THE MACROECO-NOMIC POLICY CONUNDRUM
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Our debt markets are evolving slowly and
quite far from eing mature, with multitier
structure to handle risks and enable large capi-
tal flows. Several government committees
have been appointed to look into this and de-
velop corporate ond markets. However, very
little has happened at the ground level. The
absence of an efficient debt market has be-
come a major constraint for new investments,
especially in infrastructure, where det com-
ponent of a project is significantly higher. Giv-
en an underdeveloped corporate bond market
and regulatory restrictions on deposits by
nonanking sectors, a ulk of intermediation
in the debt market is per force through the
anking channels. The cost of intermediation
in our country is perhaps the highest in the
world. Typically, a good individual saver earns4 percent per annum whereas a good corpo-
rate borrower pays 12 percent per annum a
fair, marketlinked, inflationproof and risk
free return will go a long way in reducing the
diversion of savings to unproductive asset
classes such as gold and real estate. In todays
world, such spreads can exist only with regula-
tory protections because free markets else-
where in the world have driven it down to a
few asis points. Our policy makers would jus-
tify this as a social obligation to the agricul-
ture and SME sectors. However, relative totheir uran counterparts, our farmers have e-
come much poorer since independence and
the Indian SME sector is much worse than its
global counterpart as far as availability of capi-
tal is concerned.
The igger policy conundrum pertains to equi-
ties markets. Our policy makers need to under-
stand and appreciate that:
Equities are risky ut very crucial to sustain1.
high economic growth.
There can e no equities markets without2.
nancing and speculation.
Equity investing is perceived as risky and akin
to gamling. One should not forget that the
risk capital or equity capital forms the ase on
which enterprises can leverage and raise debt
capital. Without equities, no project can even
e conceived. Therefore, a healthy equity mar-
ket forms the foundation for an efficient capi-
tal market. It will also enefit individual inves-
tors over the long term as the equities market
can generate 1518 percent per annum tax
free returns compared with 78 percent re-
turns per annum in fixed income assets.
We have the most benign fiscal policy structure
for the equities capital market. Return on Equi-
ty by way of dividend and capital gains is ei-
ther taxfree or attracts lower tax rate com-
pared with interest income. The same has not
been effective nor will schemes such as Rajeev
Gandhi Equity Investment will yield much re-
sults. This is evident from the fact that only 4
percent of household savings is directed to eq-
uities and retail penetration and participation
continues to e weak. We are overly depen-
dent on investment from Foreign Institutional
Investors (FIIs) of US$ 2025 illion per an-num even though our domestic savings are
more than US$ 400 illion.
Equity investors are not lured y sops ut ex-
pectations of aovenormal profit which ovi-
ously will entail higher risk as well. We can
have a conducive environment for equities
only when our policy makers appreciate that
neither super profit nor super loss (even to a
small investor) y itself is a ad word. My fa-
vorite analogy is of a Church priest who be-
comes a football referee and does not wantplayers to e violent, wants them to avoid inju-
ries and follow queue discipline. No dout, the
game of footall has to have rules of fair play.
There are fouls and penalties for pushing, trip-
ping, and rough tackling ut normal injuries
and aggression are an essential part of the
game. In equities, although excessive specula-
tion or manipulation has to be punishable but
volatility, speculation and losses to investors,
small or ig, are part of the game.
It appears that our policy makers perceive allfinancing, intraday, and speculative activities
as undesirable or evil elements and want to en-
courage only genuine investors. The interesting
paradox is that, investors can e attracted only
in a market with financiers and speculators.
Typically, equity shareholders are owners who
do not directly manage the companys affairs.
For them, liquidity or an easy option to exit is
important. World over, in the equities markets,
liquidity is provided not y genuine investors
ut y traders, speculators, and aritragers
who essentially need financiers. The rapid
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growth of the derivative market also corrobo-
rates the same characteristic of the equity capi-
tal markets. The genuine investment transac-
tions among investors are so rare and even a
lue chip trades only a few times in a month.
For instance, millions of shares are traded in a
stock like Infosys; ut the uyers and sellers
are not those who have simultaneously got ex-
cited and unexcited aout valuation and long
term potential of the IT sector and on Infosys
as a company.
Although manipulation is not healthy, lack
of liquidity will prevent growth and partici -
pation. Our regulators frown on speculation
and on financing. SEbIs margin funding
guidelines are too onerous to secure any
meaningful response. RbI has put several re-strictions on ank finance to the capital
markets and it discourages capital market fi-
nancing y NbFCs.
As we look at the next five years, to get our in-
frastructure ready to sustain growth, the magni-
tude of capital required is staggering. Our poli-
cy makers need to have clarity on the
macroeconomic ojective, which to my mind
can be: we need to encourage directing savings
into equities, particularly from retail investors.
We should reduce our dependence on FII hot
money, which causes greater volitility in the
market. We need more competition, more
products and easy regulations in the debt mar-
kets and in anks. The fiscal, monetary, and all
other policy framework should recognise this
and e conducive.
Mr. Nirmal JainF & C I I
L (IIFL)
The views expressed in the article are authors per-
sonal views
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URGENT NEED FOR REFORMSIN INDIAN CAPITALMARKETS
O drivers of
growth in an economy is the availability
of capital to industry. Capital needs to e
availale at a reasonale cost. Capital also
needs to be available through a process that
is reasonaly ecientoth in terms of time
as well as eort required to e spent y a
company and its management. The tradition-
al sources of capital have included nancing
y anks and nancial institutions, fundinfusions (by promoters as well as other
investors such as private equity and venture
capital investors) and last ut not the least,
capital markets. A strong and stale capital
market is an essential requirement for any
economy, not least a growing economy such
as Indias.
The Indian capital markets have unfortunate-
ly, over the past couple of decades, een the
victim of a few major scams. For example, the
Big Bull scam in 1992 as well as the KetanParekh scam of 2001 both caused an immense
loss in investor confidence, and exposed cer-
tain lacunae and inadequacies in the then
prevalent regulatory mechanisms of the Indi-
an capital markets. However, in oth cases,
there were swift regulatory responses. In 1992,
there was a major overhaul of securities regu-
lations in India, resulting in the enactment of
the Securities and Exchange board of India
Act, 1992, which formed the Securities and Ex-
change board of India (SEbI). Again, after the
Ketan Parekh scam, SEbI responded swiftly
with several measures, including imposing
several risk management reforms such as in-
troducing additional deposit margins, placing
restrictions on short selling, introducing mark
to market margins and intraday limits, cir-
cuit reakers, etc. SEbIs primary focus has
een the protection of the retail investor,
while at the same time endeavoring to intro-
duce reforms and plug policy vacuums.
However, since the gloal recession struck in
200809, arring a few periods of frantic ac -
tivity, the Indian capital markets have suf-
fered from longer periods of lethargy. Initial
Pulic Offerings (IPOs) of a significant size
have een few and far etween, and listed
companies have also faced constraints in ac-
cessing the capital markets. The time has
therefore come, for SEbI to implement re-
forms in securities regulations, oth sustan-
tive and procedural, designed to (i) make it
easier for companies to access the capitalmarkets, and (ii) oost investor confidence. A
few suggested reforms in key areas are set out
below:
IPO ProcessThe IPO process in India is currently a fairly
time consuming and cumersome process.
An IPO would typically take a minimum of
four to six months to complete, at est. The
timeline and disclosures involved in an IPO
by an Indian company typically result in
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higher time and transaction costs being im-
posed on the issuer company. This is a result
primarily of two factors:
Extensive disclosures eing required to e1.
made in the oer document, and
SEbI not clearing dra oer documents in2.
a timebound manner
The disclosure requirements for offer docu-
ments presently contain a significant amount
of quantitative disclosures, which are time
consuming to prepare, and which would pre-
sumably not have a material bearing on an
investors investment decision. Examples of
these include (i) details of all litigations
against the issuer company, its susidiariesand group companies, irrespective of materi-
ality, and (ii) details of all approvals required
for the usiness of the company, irrespective
of materiality. Indian investors have ecome
increasingly more sophisticated, and it would
be better if they are provided with disclosures
that are qualitatively material in the context
of their investment decision, as opposed to
voluminous offer documents that make it dif-
ficult to find and analyze the material issues.
It should also be made mandatory for SEBI torespond with comments on draft offer docu-
ments in a time ound manner. In the present
market conditions, windows of opportunity
open and close within very short timespans. A
clear timeframe for a response from SEBI on
offer documents would go a long way towards
enabling issuers and merchant bankers to
plan offering schedules for transactions with a
greater degree of certainty.
Preferential AllotmentsThe floor price for preferential allotments(to persons other than qualified institutional
uyers) is currently the higher of the average
of the weekly high and low of the closing
prices of the shares for (i) 26 weeks, or (ii) 2
weeks, in oth cases, preceding the date fall -
ing 30 days prior to the shareholder meeting
where the preferential allotment is ap-
proved. However, the floor price for Quali-
fied Institutional Placements (QIPs) is the
average of the weekly high and low of the
closing prices of the shares for the 2 weeks
prior to the date that the board of directors
decides to open the proposed issue. In order
to encourage equity investments in compa-
nies (y private equity and other investors),
it is suggested that the pricing guidelines for
QIPs be replicated for preferential allot-
ments, provided that such allotments are not
made to promoters or persons related to or
associated with the promoters of the compa-
ny. This would make equity investments in
listed companies more attractive to inves-
tors.
Minimum Public ShareholdingNormsCurrently, there is a uniform requirement for
listed companies (other than a few limitedexcepted class of companies) to have a mini-
mum pulic shareholding of 25 percent.
Companies that do not presently meet this
requirement are required to ensure compli-
ance y June, 2013. Further, the 25 percent
limit can only be achieved through one or
more of the prescried methods. Until re-
cently, these methods were limited to prima-
ry and / or secondary pulic offers through
prospectuses, institutional placement pro-
grams and offers for sale through the stock
exchanges. However, recently, two newroutes were added, namely rights issues or
onus issues to the pulic shareholders, with
the promoters / promoter group forgoing
their respective entitlements.
While the recent additions of rights and bo-
nus issues are welcome, it should e noted
that all the prescribed modes of compliance
(with the exception of onus issues) are
heavily dependent on market conditions and
investor appetite, in order to e successful.
In light of the uncertainty in the global anddomestic markets, SEbI may consider per-
mitting additional modes of compliance,
such as preferential allotments and private
sales y promoters, whether through the
stock markets or otherwise. Appropriate con-
ditions can be introduced to ensure that
such allotments / sales are not undertaken
to persons who are related to the promoters
or who have any arrangements with the pro-
moters with respect to passing back the eco-
nomic or voting benefit of the shares back to
the promoters.
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C: The above suggestions are
unfortunately only indicative of the re-
forms that are required in Indian securities
regulations. There are a numer of other ar-
eas that require a relook from SEbI, including
(i) regulations relating to delisting (with a spe-
cial emphasis on the price discovery mecha-
nism), (ii) insider trading, (iii) corporate gover-
nance requirements, and (iv) continuous
listing requirements. SEbI should also e care-
ful not to take any measures that may be seen
as making it more difficult companies from
accessing the capital marketsSEbIs recent
proposal on introducing a mandatory safety
net mechanism for IPOs is an example of such
a measure.
As discussed earlier, the driving force ehindmany of the changes that SEBI has made to
Indian securities regulations over the past two
decades has been the tightrope of protecting
retail investors, while at the same time mak-
ing efforts to develop and deepen the capital
markets. Whilst the simultaneously proactive
and cautious approach hitherto followed by
SEBI has certainly resulted in enhanced inves-
tor comfort and disclosure requirements, SEbI
has great challenges ahead of it in the ever
evolving Indian securities market, especially
in light of local and gloal market conditions.
The regulators will need to ensure a well rea-
soned and rational approach to meeting these
challenges, including taking into account the
views of all major stakeholders, including
market intermediaries, legal experts and most
importantly, investors.
Ms. Zia Mody
M P AZb & P
The views expressed in the article are authors per-
sonal views
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T B C G C I I | 15
CAPITAL MARKETS CRITICAL FOR OVERALL
ECONOMIC GROWTH
A , nancial markets
have een a longstanding determinant
in the overall economic growth of any
country. Well developed capital markets, oth
primary and secondary, contriute not only
to ecient capital raising opportunities for
companies from oth onshore and oshore
sources, ut also assist with ecient moili-
zation of savings and eective allocation of
nancial resources towards increasing theinvestment rate, across various sectors of the
economy.
Over the years, these interlinkages have een
extensively analyzed through various studies,
statistics and other theoretical literature. For
instance, in 1873, in a pulication titledLom-
bard Street, Walter bagehot argued that it was
Englands efficient capital markets in the 19th
century that made the industrial revolution
possile. A World bank working paper pu-
lished in 1996 also rought this corelation tothe forefront and on the basis of various em-
pirical data, concluded that stock market
growth indicators, for example, size, liquidity,
volatility, and integration with overseas capi-
tal markets are correlated with economic
growth.1Another important contribution of
the capital markets is its key role in assisting
with the gloalization of an economy, y in-
creasing access to foreign capital, which has
proven to be very essential and productive for
developing economies such as India, especial-
ly in its post lieralization growth period.
Key Factors for the Growth ofCapital MarketsIt is important to note that the stock markets,
in isolation, are unlikely to stimulate econom-
ic growth and effective resource allocation us-
ing the capital markets is possible only where
the overall economic indicators of a country
are efficient. Therefore, the development of
stock markets is not dependent on the govern-
ment and the securities market regulatoralone. Rather, the overall economic health of
the country is the strongest determining fac-
tor for its capital markets to develop and
flourish. In India, a comination of legal hur-
dles, lack of institutional reforms, policy paral-
ysis and uncertainty on tax treatment, allega-
tions of corruption across sectors have acted
as an investment deterrent in the recent past.
The Vodafone judgment of the supreme court
as well as the introduction of data protection
measures in the Information Technology Act,
2000 have helped in restoring investor confi-dence. However, major reforms are needed in
other areas such as labour and employment
laws, privacy laws, direct tax laws (especially
post the Finance Act, 2012 and the Shome
Committee Report), infrastructure law, land
acquisitions laws and antigraft laws in order
to improve investment sentiment and enable
effective contribution by the capital markets
to the growth of Indian economy.
There is a lot of literature around the vari-
ous factors that must e strengthened, in or-
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16 | D C MD C M
der to influence the growth of the capital
markets and thereby the growth of the econ-
omy. An interesting paper, pulished in 2004,
has identified some key factors to set such
economies on the right path of capital re-
source allocation.2A brief understanding of
these factors, along with their role and im-
portance visvisthe Indian economy is set
out below:
I
A strong investor protection regime goes a
long way in limiting the ause y corporates.
The investor protection regime in India has
its asis in the estalishment of SEbI, as is
evident from the preamle to the SEbI act,
1992, which states that SEbI was estalished
with the primary goal of investor protection.The erstwhile Disclosure and Investor Pro-
tection Guidelines and the current SEBI
ICDR Regulations mandate disclosure and
fulfilment of other parameters by issuer
companies with the ultimate aim of protect-
ing the rights of the investors. Disgorgement
of illgotten gains in the 2006 IPO scam by
SEbI is an important milestone in this area.
The recent Sahara order is also of signifi-
cance where supreme court has directed Sa-
hara to refund INR 24,000 crores, raised y
two of its group companies without compli-ance with the pulic issue process. In fact,
an approach paper issued by FSLRC also
seeks to take the investor protection regime
further by proposing constitution of a sepa-
rate redressal mechanism for consumer com-
plaints. Apart from the aove, investor
awareness programs are also frequently un-
dertaken y the regulator, exchanges and
other institutions, to uild stronger founda-
tions for investor protection and education
in the Indian markets.
Recently, SEbI has also sought to offer addi -
tional protection to retail investors by pro-
posing a mandatory safety net mechanism
for specified securities in pulic issues. The
SEBI (Framework for Rejection of Draft Of-
fer Documents) Order, 2012 entitles SEbI to
weed out undesirable or ineligible public of-
fers. Whilst the intent ehind these two re -
forms is laudale, a safety net mechanism
takes away the equity risk of an investor and
the guidelines on rejection of offer docu-
ments effectively introduces a meritased
regulation of capital markets, which was
done away with the abolition of the Control-
ler of Capital Issues decades ago.
C
It is fairly common in India for large corporate
groups, with a wide network of usinesses and
interlinked structures to remain controlled y
a small group of persons. To ensure transparen-
cy from a corporate governance perspective, es-
pecially in such companies, India law has put
in place a numer of checks and alances. For
instance, the Companies Act requires every di-
rector of a company to make disclosure of the
nature of his concern or interest in a contract
or arrangement (present or proposed) entered
y or on ehalf of the company.3A significant
step in this regard was also taken by introduc-tion of independent directors in India. based
on the recommendations of Kumar Mangalam
birla committee, Clause 49 was incorporated in
the Listing Agreement in 200001 which en-
shrined the basics of independence of direc-
tors. It noted that independence of the oard is
critical in ensuring that the management fulfils
its oversight and role objectively and holds it-
self accountale to the shareholders. Various
committees like Naresh Chandra Committee
Report, 2003, Narayan Murthy Committee Re-
port, 2003, Dr. Irani Committee Report, 2005revised and strengthened the definition of in-
dependence, structure and composition of the
oard, appointment and remuneration of inde-
pendent directors and their inclusion in audit
committees.
Despite such initiatives, there continue to e
instances where the appointment of inde-
pendent or nonexecutive directors remains
a matter of mere legal compliance and there
are instances where independent directors
remain personally known to the promoters,without regard to a specified selection pro-
cess or other qualifications for their appoint-
ment. These are matters of concern that
need to be addressed systemically
C
Corporate transparency enables informed de-
cisionmaking y investors and can e
achieved y mandating adequate disclosures
from companies. Ranging from disclosures in
offer documents for accessing pulic funds,
up until disclosures on an ongoing basis
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aout material events, financial performance,
insider trading and takeover code filings etc.,
sea changes has been brought about in the
disclosure regime in India and it is now com-
parale to the est, gloally. besides informa-
tion dissemination, corporate transparency
has also been achieved and made effective by
electronic portals like MCA21 as well as web-
sites of stock exchanges, which have not only
simplified filing but also made access to data
simpler and more efficient.
C
Openness to the gloal economy, particular-
ly capital account openness, is another im -
portant factor. Capital openness promotes
capital inflow, increases competition and in
turn efficiency, and also provides financialacking to local entrepreneurs.
The Foreign Exchange Regulation Act, 1973
was the primary statute that governed for-
eign investments but its provisions were re-
strictive and did not encourage investment,
oth inward and outward. The announce-
ment of liberalization policy in 1991 ushered
in foreign direct investment and equity port-
folio inflows. Susequently, it allowed det
instruments and equity outflows also, al-
though crossorder credit flows have eenrelatively limited. Since the 1990s, the road
approach towards permitting foreign direct
investment has been taken through a dual
route, for example automatic and discretion-
ary, with the amit of the automatic route
being progressively enlarged to almost all
the sectors, coupled with higher sectoral
caps stipulated for such investments. The
concept of capital account lieralization,
first mooted in the 1997 Tarapore Commit-
tee Report, has also een the driving force
of many reforms. Consequently, net capitalinflows shot up from 2.2 percent of GDP in
199091 to around 9 percent in 200708.
The foreign investment, including oth the
direct investment and portfolio investment,
increased from US$ 103 million in 199091
to US$ 61,851 million in 201011.
Mapping the Development ofIndian Capital MarketsAlthough capital markets in India evolved
around the close of 18th century, the 1990s
were perhaps the most significant. This de-
cade was characterized by a spate of reforms
eing introduced in the country, in terms of
a new industrial policy, freedom to issuers to
issue securities at market determined rates,
setting up of new stock exchanges, introduc-
tion of screen ased trading, improved set-
tlement mechanisms. In the 21stcentury, the
Indian securities market continued to wit-
ness introduction of new financial products
like IDRs, FCCbs, FCEbs along with signifi-
cant improvements in corporate governance.
One can gauge the impact of reforms in the
securities market on the economy from the
GDP growth of 9.8 percent achieved in the
last quarter of 200607. The corelation e -
tween stock market and economic growth is
also apparent when the stock marketplunged post the 2008 peak leaving the
growth of the economy at 6.7 percent in
200809 (AprilMarch).
Way ForwardIn its 2008 report, the High Level Committee
on Financial Sector Reforms headed by Ra-
ghuram G. Rajan aptly noted that Given the
right environment, financial sector reforms can
add between a percentage point and two to the
economic growth rate4
. Empirical data alsosupports this hypothesis, as stock market de-
velopment, over the years has mirrored in
the increase in GDP growth rate from 1.40
percent in 199192 to 9.0 percent in 2007
08, and major reforms are required to keep
up this growth rate. In the past few months,
the government has taken a positive step
ahead with the introduction of 51 percent
foreign direct investment in multirand re-
tail as well as relaxation of norms for foreign
direct investment in the aviation, insurance
and pension sectors. These measures are notonly likely to encourage investments in In-
dia, ut will also act as a significant confi-
dence ooster to market sentiment. Setting
up of the FSLRC is also aimed at creating a
more stale and resilient financial sector,
and FSLRC has in fact, suggested various re-
forms to revise and ensure consistency
across financial sector laws in its approach
paper released in Octoer 2012. However,
the Indian markets continue to require a sec -
ond generation of reforms in certain finan-
cial segments such as corporate bond mar-
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18 | D C MD C M
ket, currency derivatives, etc., and in making
the IDR space more attractive for foreign
companies to assist with economic growth,
going forward.
Mr. Cyril ShroffM P A
M & S A. S &
C
The views expressed in the article are authors per-
sonal views
NOTE:
Levine, Ross and Zervos, Sara (1996) Stock Markets,1.
Banks, and Economic Growth, World Bank Policy Re-
search Working Paper, No. 1960
Durnev, Art, et al, (2004) Capital Markets and Capital2.
Allocation: Implications for Economies in Transition,
Economics of Transition, Vol. 12(4), 593634.
Sections 299, 309(1) and Schedule VI of the Companies3.
Act, 1956.High Level Committee on Financial Sector Reforms with4.
Raghuram G. Rajan as its Chairman was set up on August
17, 2007 and the committee submitted its report on
September 12, 2008.
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T B C G C I I | 19
I the largest domestic savings
markets in the world. However, of this overall
savings, equity / capital market participation is
extremely low. A SEbIsponsored household
survey provides some startling insights into
household saving preferences. The study
estimated that only 11 percent of Indian
households (24.5 million of 227 million) invest
in equity, det, mutual funds, derivatives and
other instruments in the capital market. Theremaining 89 percent are also likely to be net
savers, ut rely on nonrisky avenues such as
anks, insurance or post oce savings instru-
ments. While this 11 percent is very dierent for
uran and rural India, it still translates into only
20 percent for urban households and 6 percent
for rural households. And the unfortunate part
is that this percentage has not changed much
over the past few years. As a result, in spite of a
large amount of aggregate savings, there is an
acute shortage of domestic risk capital.
This is compounded by the disparity across ge-
ographies. The equity AuM is extremely concen-
trated, with the top ten cities accounting for ap-
proximately 74 percent of the total equity AuM
and the top 30 cities accounting for about 90
percent of total equity AuM. This would e simi-
lar for direct equity as well. While locations e-
yond the top ten cities are gaining share contin-
uously, the movement is slow and steady. The
share of AuM beyond the top ten cities has in-
creased from about 10 percent in 2003 to about
26 percent in 2011. The disparity ecome stark
when one compares the spread of equity with
other financial assets, example insurance and
ank FDs. While the top 10 cities account for
nearly 75 percent of the equity investments,
they account for only 35 percent of the anks
term deposits (savings plus fixed deposit).
There are a variety of reasons holding back re-
tail participation in equity. And it is going to re-
quire action on several counts to change this.The key areas that need to be addressed are as
listed below:
1. Enhancing customer awarenessThe lack of awareness or the amount of igno-
rance about capital markets in India is incred-
ile. Among the households (89 percent) that
did not invest in the capital markets (SEBI sur-
vey mentioned aove), nearly 41 percent felt
that they had inadequate information aout fi-
nancial markets and lacked investment skills.This perception was prevalent across various in-
come groups and education categories. In addi-
tion, a stunning 16.5 percent of the most educat-
ed and 16 percent of the upper middle and
upper income groups thought that investments
in the capital markets were not safe. It is this ig-
norance that needs to e addressed.
It is critical that customers are educated about
the concept of risk return tradeoffs. Unfortu-
nately, many Indian customers are still living in
the License Raj, with the IPO / NFO premium
FINDING THE POT OFGOLD AT THE END OF THE
RAInbOW WHERE IS THEELUSIVE RETAIL INVESTOR
IN EQUITIES
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market. The elief is that once one gets alloca-
tions in the IPO / NFO, attractive returns are
guaranteed. And when that does not happen, it
results in huge disappointment. This takes us
ack to the 80s and 90s, when, every time a new
car model was launched, people ooked wheth-
er then wanted a car or not, just so that they
could sell their ooking with the on premium.
It is high time that the Indian customers come
out of this World of scarcityaccess is critical
for value generation mindset. Additionally, the
other key element is timing. Most investors typi-
cally get the cycle completely wrong. They get in
when the market has gone up and exit when
the market starts going south.
The India market is going to need serious
awareness programs to address the largeamount of ignorance that exists today.
2. Creating a value proposition forthe customers through productsand performanceThe second element that needs to be looked
at is that of a clear value proposition for in-
vestors. And this has to address two simple
levers (i) performance / returns; and (ii)
meeting a specific customer need.
While the ase product is equity, there are mul-
tiple product variantsgrowth versus value eq-
uity, ETFs versus actively managed equity funds,
SIPs versus one time investment, Portfolio Man-
aged Services (PMS) and structured products.
And in each of these cases, the important ele-
ment of the proposition has to e performance /
returns commensurate with the risk that the
customer is taking. This oviously presupposes
a certain ase customer awareness.
3. Ensuring an active distributionnetworkorganizing the unorga-nizedThe Indian market today has three key distri-
ution channels for equity mutual funds and
direct equitydistriutors, anks and Inde-
pendent Financial Advisors (IFAs). The not so
recent ban on entry load and hence the corre-
sponding reduction in the commissions for
the channels has resulted in a major overhaul
of the distriution. Large distriutors with
scale and negotiation ability have negotiated
etter terms and are in a position to survive,
while the smaller ones are hurting.
Going forward, anks and distriutors will
evolve to meet customer requirements. but, it
is more an evolution than a revolution. Howev-
er, in the case of IFAs, there is serious need for
major overhaul. This is where the need of the
hour is to organizes the unorganized sector
and therein lies the challenge for the Indian
market. Get this right, and we have a roust in-
dependent advisor network, get this wrong,
and the channel disappears. Also, the other in-
teresting opportunity for India is leveraging af-
finity networks. Gloally, different affinity net-
works have succeeded in different markets.
There are multiple possiilities, ranging from
the more tried and tested post office and retail-ers, to the Teclos, to the communities like IFF-
CO, Amul, ITC Chaupals. The list is long. The
question for India is, Which of the affinity net-
works will work in an economically viable
manner?
4. Continuing with favourableregulationsThe tax regime has always een favourale for
equity investmentsoth direct and mutual
funds. This is going to have to continue, ecauseIndia really needs the risk capital.
In summary, while the market has evolved sig-
nificantly over the past decade, it is as always a
case of the glass half full versus the glass half
empty. India has a long journey to continue.
It will need multiple entities, SEbI, Ministry of
finance, AMCs, Industry odies, etc. to work to-
gether on multiple fronts, else the pot of gold
will remain elusive.
The words of Robert Frost capture this senti-
ment the best
The woods are lovely, dark and deep. but I
have promises to keep, And miles to go e -
fore I sleep, And miles to go efore I sleep.
Alpesh ShahS P D bCG
The views expressed in the article are authors per-
sonal views
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I H percent of
GDP in FY11. Aout half of the savings
went to physical assets like gold and real
estate. Financial savings comprised of 13
percent in currency, 47 percent in ank
deposits, 24 percent in insurance, 9 percent
in pension and provident funds and 7
percent in small savings. Majority of finan-
cial savings is unlikely to earn real return as
inflation levels are higher. This compositionreflects that Indians are great savers but
poor investors. Increased allocation to
physical savings is also proving the point
that financial savings probably have not
given adequate real return to Indian house-
holds. Inadequate real return on financial
savings is mostly hitting the retail investors.
HNIs are able to generate far higher real
return due to combination of factors like
scale and size of investment, leverage,
superior knowledge and range of investment
product. Indian society is experiencingwidening inequality as HNIs are ale to
compound their already higher wealth at a
faster pace than the retail investor on their
meagre wealth.
Corporate onds can provide adequate real re-
turn to investors. Corporate fixed deposit was
part and parcel of an average retail investors
life in not so distant past. Corporate fixed de-
posit market lost its appeal and diminished in
size as investors looked at coupon rather than
safety, distriutors othered for incentive rath-
er than client interest and regulations were by-
passed through innovative structures like plan-
tation scheme. Focus on return on principal
rather than return of principal led to the de-
cline of the corporate fixed deposit market.
Corporate bond market could have easily filled
the void left y corporate fixed deposits. How-
ever in spite of several steps taken by regula-
tors to develop the corporate ond market, itremains a glass half full or half empty story. In-
troduction of trading and settlement system
like NDS for gilts, hedging product like interest
rate futures and increased FII participation has
deepened corporate ond market. A lot of
thinking has been done to further develop cor-
porate bond market but it has not been con-
verted into actions for various reasons.
Following steps can be taken to deepen the cor-
porate bond market which is necessary to mi-
grate physical saving to financial saving andprovide longterm financing for infrastructure
development:
Include corporate bonds as an acceptablesecurity in Collateralised Borrowing and
Lending Oligation (CbLO) with reasonale
margin
Allow pension and PF trusts to invest inhigher credit corporate bonds from the
limited freedom of investing in dual highest
credit rated bonds
DEEPENING THE INDIANCORPORATE BOND MARKET
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Allow pension and PF trusts to sell theshorter maturity corporate bonds in the
market to create liquidity at the shortend
and appetite for investment at longend
Incentivize insurance companies to sell theshorter maturity corporate bonds in the
market to create liquidity
Hair cut for corporate bond in repo marketshould be duration weighted rather than
at rate
Introduce netting in corporate bondsettlement (DVP III) like in gilt market
encouraging ecient utilization of capital
Expand interest rate futures across the maturity spectrum to generate liquidityalong with cash settlement of interest rate
futures
Introduce speedy and sure enforcement ofsecurity. Investors condence on measures
like Section 138 in case of cheque ouncing
has evaporated with the time consuming
process of law. A high yield market can not
develop in India unless there is surety of
enforcement of security. A lot of douts are
prevailing about fundamental matters likeoptions, selling of pledged securities etc.
These fears are pushing investor towards
highest rated bonds depriving lower rated
issuers from market access
Encourage larger size of issuance bycapping stamp duty on issuance and
allowing reissuance of security
Lay out clear process for attracting FII owsin infrastructure debt starting with simpler
denition of infrastructure and assetacked model of nancing
bring OIS (swap for hedging) market on theexchange to facilitate etter participation
as well as reduce the settlement risk
Reduce the cost of retail distribution ofonds. It can e done through comining
the IPO process with placement through
the exchange or online platform. Allow
appropriate advertisement for secondary
placement of bonds to gain traction from
retail investors
Popularize structured product throughgeneric exchange traded products. Retail
investors participation in Indian equity
markets has declined over last two
decades as their experience has een
unpleasant. Entry in a ullish market and
exit in a earish market along with wrong
stock selection has caused this unpleasant
experience. Structured product could act
as a good bridge for money moving fromxed income to equity y providing safety
of det and partial return of equity. An
exchange ased distriution will ring
much needed transparency in the struc-
tured product and enhance retail partici-
pation
Clearly the above measures are not all encom-
passing to develop a vibrant corporate bond
market. May e some of them will work and
some of them will not. May e some etter
suggestions will come on the way as we imple-ment this measures. May e there will e con -
sensus on some of the measures and outright
rejection of few. What is important is to contin-
ue the process of deepening of Indian corpo-
rate bond market through actions rather than
waiting for the perfect solution.
Mr. Nilesh ShahD A D
The views expressed in the article are authors per-sonal views
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T B C G C I I | 23
I -
depended on the strong domestic
ank nancing sector as the primary source
of det funding. However, there exist certain
constraints on ank nancing for example
single and group exposure limits, sectoral
restrictions. The existence of a virant det
capital market is imperative from a macro
economic perspective to provide mechanisms
for greater sources of funding and liquidityand for minimization of risk in any economy.
The development of the domestic bond
market would result in lesser systemic strain
for oth anks (for example, depositors) and
corporates (for their sources of funding).
Strong det capital markets facilitate nan-
cial intermediation, put providers and
consumers of capital together and make the
credit evaluation and discovery process more
transparent.
The high and growing savings amounts of cus-tomers in India (who would want higher yield-
ing instruments than ank deposits) together
with the approximately 9,000 listed compa-
nies is a powerful combination for the devel-
opment of the det capital markets in India.
More recently, we have seen an increase in the
numer of pulic offers of onds (for example
offers to more than 49 persons). Although
starting from a low ase, the numer has in-
creased to 12 issues in 2011 from 1 issue in
2008 and 3 issues in 2010. Private placements
of corporate bonds have also increased from
744 issues in 200708 to 1,278 issues in 2009
10 and 1,404 in 201011.
As a proportion of gloal GDP, the world ond
market increased to 130 percent at the end of
2010 from 80 percent a decade earlier. Accord-
ing to a survey conducted by IOSCO in No-
vemer 2011, on corporate ond markets for
emerging markets, the size of the ond mar-
kets are projected to rise significantly in thenext few years on the ack of increased eco-
nomic growth, greater local and foreign invest-
ments to fund large scale infrastructure proj-
ects, and the narrowing of gaps in income
between emerging markets and developing
markets. China (23 percent), Korea (57 per-
cent), India (21 percent), Malaysia (40 percent)
and Thailand (20 percent) dominate the cor-
porate bond market arena and account for
more than 80 percent of the total corporate
ond markets among the emerging markets.
There are various challenges, high rates on
withholding tax for foreign investors on inter-
est income from bonds and high rates of
stamp duty applicale on onds. Any change
to the investmentgrade rating of India or ex-
treme volatility in the US Dollar to Indian Ru-
pee exchange may well deter the growth of In -
dias corporate ond market.
While, the foundations have een laid for the
corporate debt market in India to develop
over the next decade, there are certain other
KEY MONETARY REFORMSFOR THE DEVELOPMENT OF
DEBT MARKETS IN INDIA
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measures that may also e considered. The
purpose of this article is to analyze certain
key monetary reforms in the taxation system
and stamp duties payable on bonds which
may ease the way forward for a vibrant debt
market.
Making the Stamp Duty RegimeMore Investor FriendlyThe stamp duty on bonds is a central subject
and is governed y the Indian Stamp Act,
1899. While the same has een amended to
make it uniform across all states, there is an
urgent need to address the issue of differen-
tial stamp duties levied by various state gov-
ernments on bonds secured by immovable
property.
Currently, stamp duty on onds (unsecured or
secured with collateral other than immovable
property) as amended in 2008 is 0.05 percent
per year of the face value of the bond subject
to a maximum of 0.25 percent or INR
25,00,000, whichever is lower. Further, there is
no stamp duty on transfer of bonds issued in
dematerialized form.
However, where there is a registered mortgage
deed (which is duly stamped in respect of thefull amount of onds to e issued), in most
states there is no further stamp duty on the
actual onds issued for example the onds
are exempt from stamp duty. Whilst the stamp
duty on onds has een capped, the stamp
duty payable on the mortgage deed (to be de-
termined by the stamp statutes applicable in
each state) is different. Further, stamp duty
payable in some states is capped whereas in
other states it is ad valorem.
Therefore, the stamp duty on onds should ereduced to a nominal rate. The rate may e
made INR 200 (similar to a loan agreement if
executed in New Delhi) or lesser so that there
is a level playing field with the transaction
costs applicale to the ank loans market.
Further, there should e no differentiation in
rates between secured or unsecured (whether
secured by immovable property or other as-
sets) and there should e a uniform nominal
amount in all states. This may e achieved y
having a nominal amount of stamp duty pay-
able on a mortgage deed for bonds in all
states which will require to e so determined
by each state government in consultation with
the central government.
Separately, the Indian Stamp Act is silent on
the stamp duty for reissuance of the same
security. Hence currently it is treated as a
fresh issuance for the purposes of the stamp
duty and stampable at the above mentioned
rates again. Therefore, amendments should e
made to the Indian Stamp Act to clarify that
reissuance of onds should e stampale at
no or nominal stamp duty.
Further, transfer of onds, while in demateri-
alized form is exempt, in physical form is still
stampable with differing rates as per applica-
ble state laws even if secured by a mortgagedeed. Transfer in physical form should there-
fore also e made exempt from stamp duty
which will result in more participation from
retail investors who traditionally prefer to
hold onds in physical form.
Removing Tax Deduction atSource (TDS) and Reducing With-holding Tax (WHT) on Interestfor all Bonds Issuances
One of the key recommendations in the TheReport of the High Level Expert Committee
on Corporate Bonds and Securitization
commissioned by the Union Government and
chaired y R. H. Patil in 2005 was that the
TDS rules for corporate bonds should be simi-
lar to the ones applicable to government secu-
rities. Currently, government securities do not
attract TDS on interest income.
After amendments to the Income Tax Act,
1961 (IT Act), no tax is required to e deduct-
ed on interest income payable to an Indianresident on securities (including corporate
onds) issued in dematerialized form and if
listed on a recognized stock exchange in India
and at 10 percent if the bonds are issued in
physical form. Further, TDS is not applicale
as regards interest on corporate bonds (all
types) payale to certain insurance companies
who hold full beneficial interest in such
onds.
However, the aforementioned exemptions for
domestic investors are not available for for-
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eign investors. WHT on interest on onds as
per the IT Act is generally 20 percent for for-
eign investors except, where such rate for cer-
tain specific types of bonds is not specifically
reduced by the IT Act itself or a more benefi-
cial rate is provided under a Doule Taxation
Avoidance Agreement (DTAA) with a specific
country (for example the WHT on interest for
Singapore, Cyprus, and Luxemourg is 10 per-
cent whereas for Mauritius it is 20 percent).
The Ministry of Finance has introduced sec-
tion 194LC in the IT Act through the Finance
Act, 2012. This new section has reduced the
WHT on interest on long term infrastructure
onds in foreign currency and External Com-
mercial borrowings (ECbs) which are raised
under a loan agreement, from 20 percent to 5percent. by a circular in Septemer 2012, the
Central board of Direct Taxes (CDbT) has
done away with the requirement of otaining
prior central government approval for availing
the reduced rate of WHT of 5 percent. The
lower rate applies to monies borrowed or
onds issued etween July 1, 2012 to June 30,
2015.
While the above measures are steps in the
right direction for easing the cost on long term
infrastructure onds for foreign investors,such steps should include all bonds or a wider
range of onds. The scope of section 194LC of
the IT Act should e expanded to include
bond issuances by all corporates which are
permitted under the ECB regulations to raise
ECbs. Other than the ECb regulations, corpo-
rates have been permitted to raise debt by is-
suance of NonConvertile Deentures
(NCDs) / commercial papers and onds to For-
eign Institutional Investors (FIIs) under Sched-
ule 5 of the Foreign Exchange Management
(Transfer or Issue of Security by a person resi-dent outside India) Regulations, 2000. Section
194LC of the IT Act does not provide the re-
duced rate of WHT for bonds issued to FIIs
and should e extended to cover them.
Benefits of reduced WHT on interest should
be made uniformly applicable to all debt in-
struments and should not be limited to only
specific sectors and for limited time periods
for a cost efficient Indian det market. For the
development of the det market, it is conse-
quently suggested that exemption from TDS
e extended to unlisted onds and onds held
in physical form. WHT on interest for all
onds held y any nonresident investor
should e consistently reduced. Further, there
should e no differentiation in taxation on in-
terest for bonds based on the currency of is-
sue.
Introducing Bonds with TaxIncentivesHistorically, onds having tax enefits have
been introduced by the central government
for domestic investors and entities permitted
have included a select group of public sector
entities or Nonbanking Financial Companies
(NbFCs) in the infrastructure finance sector.
In 2010, a new section 80CCF was introduced
under the IT Act that provided income tax de-
duction of INR 20,000 in addition to INR
1,00,000 availale under other provisions for
claiming tax deductions for investments made
in the long term infrastructure onds. Eligile
borrowers for this category of bonds were re-
stricted to Industrial Finance Corporation of
India, Life Insurance Corporation of India, In-
frastructure Development Finance Company
and NBFCs who are classified as an infrastruc-
ture finance company y the RbI. Only resi-dent individuals and Hindu Undivided Family
(HUFs)are permitted to invest in these onds.
Any investment in such bonds up to INR
20,000 is eligile for tax deduction from the
taxale income. Section 80CCF onds have
een discontinued in the current fiscal year.
80CCF bonds should be reintroduced in the
next financial year ut it should e reintro-
duced with modifications such as (i) increased
numbers of eligible issuers including issuers
in the noninfrastructure sectors, (ii) roaderase of domestic investors, and (iii) permitting
foreign investors (who may not be able to get
tax enefits ut should e allowed to invest).
To take another example, tax free onds had
een introduced in 2011 having exemption
from tax on interest on the onds under Sec-
tion 10(15)(iv)(h) of the IT Act. In 2011 only
four issuers had been permitted to issue such
ondsNational Highways Authority of India,
Indian Railway Finance Corporation Limited,
Housing and Urban Development Corpora-
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tion Limited, and Power Finance Corporation.
In 2012, the central government has issued a
notification permitting tax free onds for sev-
en additional issuersIndia Infrastructure Fi-
nance Company Limited, Housing and Uran
Development Corporation Limited, National
Housing bank, Rural Electrical Corporation,
Jawaharlal Nehru Port Trust , Dredging Corpo-
ration of India Limited, and Ennore Port Lim-
ited. The investor ase has also een in-
creased y permitting qualified institutional
uyers, corporates, high net worth individuals,
and retail individual investors.
The central government has taken the right
step by increasing the investor base for such
tax free onds and in order to make it a more
effective step, many more types of issuersshould be permitted to issue such bonds as
the eligile issuers are still very limited.
Section 80CCF onds and tax free onds have
been very effective in the market and have
generated a lot of investor interest due to
their lucrative enefits. Introduction of such
category of bonds will definitely boost the
corporate ond market in India.
Leveling the Field Removingthe Process of Buying Debt LimitsA key factor to the development of any capital
market is the participation of foreign inves-
tors. In India, the way in which this happens is
investments by FIIs and Qualified Financial
Investors (QFIs). While investments in the eq-
uity markets have been facilitated to a great
extent, FIIs having more or less een placed
at an equal footing with domestic investors,
the same is not the case for the debt market
as FIIs do not have the same standing as do-
mestic investors.
A key monetary area where FIIs are in a dis-
advantageous position compared to domestic
investors and QFIs is the expensive process of
actually buying debt limits for subscribing to
NCDs. In order to invest in NCDs in India, an
FII first needs to procure the debt investment
limits. While part of the investment limit is
allocated y Securities and Exchange board of
India (SEbI) y way of an open idding pro -
cess, the remainder is allocated on a first
come first served asis, suject to the condi-
tions and procedure stipulated in the circulars
issued y it from time to time in this regard.
The maximum allocation limit for an FII y
bidding process as well as by first come first
served asis is changed frequently y the
SEbI.
This process not only limits the ability of FIIs
to invest in the NCDs as FIIs are first required
to procure debt limits before purchasing
NCDs in the market but of course affects their
net return as the debt limits purchased is a
cost to the FII. Such an arrangement places an
undue burden on the FII since FIIs are re-
quired to account for the time and cost re-
quired to procure det limits which is not the
case with domestic investors. This also affects
price discovery.
This is further aggravated by the fact that while
FIIs originally enjoyed a period of fifteen work-
ing days for replacement of the NCDs that have
either een disposed off or matured for exam-
ple FIIs could reinvest the proceeds received on
the expiry or sale of the initial NCDs into new
NCDs provided such investments were made
within the period of fifteen working days, this
reinvestment facility has een discontinued y
SEBI since January 2012 for all new allocations
of det limits, as a result of which reinvest-ment period shall not be allowed for all new
allocations of det limit to FIIs or suaccounts.
As regards det limits that had een acquired
prior to January 2012, the facility of reinvest-
ment will continue for the FIIs until any one of
the following thresholds is reached: (i) total
sales made from the existing det portfolio
(current det investment and the unutilized
limit currently with the entity, if any) is twice
the size of its debt portfolio as on the date of
the circular, or (ii) expiry of two years from the
date of the circular for example January 2, 2014and up to 50 percent of their debt holdings at
the end of the previous calendar year during
each calendar year post that.
Thus, fresh det limits paid for and acquired y
FIIs in the idding sessions post January 3, 2012
will lapse on either sale or at maturity and will
e allocated in susequent idding processes.
The FII now needs to purchase debt limits (in
case the debt limits were procured post January
3, 2012) every time he wishes to uy NCDs
which given auction frequencies also affects
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T B C G C I I | 27
their return since such amounts will remain
uninvested for a period following sale or re-
demption of NCDs. Further, the move could dis-
courage investments by FIIs in short term debt
instruments as any FII would seek to invest
only in long term det instruments.
Thus the requirement of FIIs to procure det
limits every time they wish to buy NCDs should
be done away with and any overseas investor
dominance may be managed through reporting
and by putting specific limits if the concern is
that FII investment in a particular issuer or in
the domestic det market is ecoming exces-
sive.
C: Several measures have been
taken to improve and develop the Indian
ond markets. Nevertheless in our view the
suggested fiscal and monetary reforms will go a
long way in incentivizing the investors and will
encourage wider participation not only by do-
mestic investors but by foreign investors as
well.
Mr. Cyril ShroffM P A
M & S A. S &
C
The views expressed in the article are authors per-
sonal views
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I a viable corporate
debt market to meet the projected invest-
ment of US$ 1 trillion required to enhance the
countrys economic growth rate in the 12th
veyear plan (201217), majority of which is
expected to come from the private sector. A
corporate debt market enables private
industry to raise funds through debt instru-
ments and channelize these into specic
sectors, including infrastructure. Infrastruc-ture nancing in India depends on the growth
of the corporate ond market. As the Ra-
ghuram Rajan report on nancial sector
reforms stated that a well developed corpo-
rate debt market provides a stable source of
funds and thus reduces volatility in the equity
market. Since the gestation periods of infra-
structure projects are generally long, nancing
these through ank loans is not feasile. This
is ecause anks accept deposits for 510
years and thus can not give 30year loans for
these projects, as this would create assetliaility mismatch. but a ank would e
perfectly comfortale uying a 30year ond
if a liquid market exists.
Despite strong economic growth and signifi-
cant financial system reforms, Indias corpo-
rate det market remains underdeveloped. A
major area of concern is that regulatory vision
of the fixed income market is tinting with
learning from the equity markets. Unfortu-
nately, this hurts rather than helps the cause
of developing the markets. Pushing corporate
debt market too fast into a compulsorily
cleared and settled mechanism is likely to
stunt the market rather than help its cause
because the nature of the players and the size
of the deals make transactions infrequent,
large and for ig oys alone. The few dozen
players in the market typically know each oth-
er and the size of many deals ensure that they
are afraid of putting it in an anonymous order
matching system as doing so would move theprice. Finally, the lack of a yield curve makes
it impossible to price corporate debt accurate-
ly as there is no benchmark on which to price
such securities.
There are certain outstanding issues pertain-
ing to the affairs of the fixed income market
in India. Since every committee set up for the
development of Indias infrastructure has rec-
ognized the need for a well developed corpo-
rate debt market for the wholesome develop-
ment of the countrys infrastructure, thedevelopment of the debt market would be a
key to higher growth for the Indian economy.
There is a need for an active cooperation
among all the concerned regulators for exam-
ple, RbI, SEbI, and the Ministry for Finance.
The following are certain broad issues to be
considered by the ministry and the concerned
regulators to provide competitors with a level
playing field in, and for creating a more ac -
tive, transparent, and orderly growth of the
corporate det market in India.
DEBT CAPITAL MARKET REFORMS REQUIRED In
CORPORATE DEBT MARKETIN INDIA
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Ministry of FinanceThe following are certain issues which require
the Ministry of Finances attention in order to
bring in policy reforms with respect to corpo-
rate bond markets in India:
First, the dissonance between the ECB bor-
rowing limits (no overall cap) for companies
and FII limits on corporate bonds make no
sense from a policy perspective. The curren-
cy risk is borne by the investor in case of FII
investmentby allowing a generous ECB
orrowing and limiting the FII exposure to
corporate debt we are importing currency
risk y regulatory fiat. In any case, they do
not substitute completely but complement
each other.
Second, the current monopoly of the Clearing
Corporation of India Limited (CCIL) in gov-
ernment securities trading and settlement has
undercut the emergence of an arbitrage free
yield curve. If what is known as a yield curve
can not be formed out of risk free government
securities, it would e impossile to form a
curve of corporate debt market yields as cor-
porate debt is priced at a premium to the risk-
less securities. For example, if riskfree one
year government security yields an 8 percent
per annum interest, an investment grade oneyear corporate debt may be priced to yield 11
percent and a more risky corporate debt at 14
percent. Similarly, a five year government se-
curity would be used to value five year corpo-
rate det paper. In the asence of this refer-
ence rate at various maturities, the market for
corporate debt is confused and remains un-
derdeveloped.
Third, in a market where only institutions
trade, and in a market where dematerializa-
tion and Permanent Account Numer (PAN)exist, there is no need for imposing TDS on
interest payments. Government securities and
certain entities are exempt from TDS, making
this an administrative nuisance and back of-
fice pain for dealing in corporate det.
Fourth, there is a logical fit etween the long
tail of liabilities of pension funds and insur-
ance companies and the possibilities of long
duration corporate onds. but today the in-
vestment guidelines create artificial alloca-
tion restricting the longterm uyers from
uying long dated corporate onds, thus
choking the supply of such instruments.
Without demand from long term purchasers
who are est suited to hold such securities,
the market would not properly develop. Sev-
eral of these would require policy and statu-
tory modifications.
Securities and Exchange Board ofIndiaThe following are certain issues to be consid-
ered by SEBI in order to promote competition
and innovation in, and for facilitating the de-
velopment of the corporate bond markets in
India:
First, SEbI currently mandate that a minimumnet worth of INR 100 crores is required for a
new stock exchange to enter the market. This
acts as an entry barrier and is not good for
healthy competition in the marketin a mod-
ern market, it is the clearance and settlement
agency which bears the risk and capital re-
quirement and thus requires to e capitalized.
Second, SEbI should permit Alternative Trad-
ing Systems (ATSs) for corporate onds. Cor-
porate ond market requires a different sys-
tem of bringing buyers and sellers togetherrather than forcing an equity like order
matching and guaranteed settlement systems
and further restricting trading to a single ex-
change may e counterproductive.
Third, current market conditions require that
there should be consistency and standardiza-
tion in coupon frequency and day count con-
ventions.
Fourth, a clear demarcation etween retail
and wholesale Qualified Institutional Place-ments (QIPs) participants in corporate ond
markets should be maintained while regulat-
ing them as QIP framework would greatly in-
crease liquidity.
Fifth, the repurchase (sale and uy ack) or
repo market is essential in creating quick li -
quidity for investors and changing the dead
weight view of corporate bonds (that they
are can not e lent while holding them, mak-
ing them unproductive during their life). In
January 2007 Ministry of Finance has clari-
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fied certain issues relating to regulatory ju-
risdiction of RBI and SEBI wherein it was
clarified that SEBI has the power to regulate
onexchange repos. SEbI should use its pow-
ers to develop the marketwhich would re-
duce the dead weight value of corporate
det.
Sixth, SEbI reduced the mark to market re-
quirement period from six month instru-
ments to three months for mutual fund hold-
ings. but investor demand for listed three
months securities is cratering and it would
be useful if SEBI clarifies that any instru-
ment with upto six months maturity (listed
or unlisted) would e carried at cost.
Reserve Bank of IndiaRbIs role as a regulator of anks is crucial
for an efficient development of bond mar-
kets in India. Following are the issues to e
considered by RBI in order to deepen the
primary and secondary markets in the cor-
porate bond market in India:
First, the limit of 5 percent on fixed income
intermediary to act as broker should be done
away with. Since a lot of active rokers do
not exist in the det market, the restrictionleads to lack of transparency as a broker has
to route its trade through another broker
who provides no service to the client or to
the market.
Second, the Negotiated Dealing System (NDS)
traders in government securities do not pay
15 percent of the trade value of brokerage
revenues as stamp duty. This creates a two
tiered system and directs orders to a fa-
voured institution, which is anticompetitive
and against the interests of the players andthe instruments. Just as pulic sector under-
takings pay the same income tax and indi -
rect tax as the private sector, the government
should not pick a public sector organization
as a winner.
Third, worldwide clearing corporations are
competitive organizations and while CCIL
should continue to perform its role in clear-
ing NDS trades, it would e in the interest of
the country and its commitment to G20
group of nations to settle more and more
trades through a clearing corporation. This
would not e possile if the countrys only
clearing corporation refuses to clear other
exchanges trades.
Fourth, RbI should allow anks to pay ro -
kerage in the Inte